It is common for startups to use contractors rather than employees at the start of their business’ life when consistent cash flow is scarce. Startup founders may also be unsure whether their business needs a full-time employee for a particular job. Utilising contractors allows a startup to outsource without having to commit to an employee and ongoing employment obligations. However, sometimes startups may even struggle to pay their contractors in cash. An alternative to paying your contractors cash is to issue them shares. This article will explain the pros and cons of issuing shares to contractors.
What Does It Mean to Issue Shares?
A business can issue shares to anyone in exchange for capital (cash) for some sort of service that has been provided. The person who receives the shares becomes a shareholder, meaning they own part of the business. The value that the shares are issued at will depend on how the business values itself or how the market values it. There are different types of shares, such as ordinary or preferred shares. Ordinary shares give shareholders the right to vote but are not given as high priority as preferred shares if, for example, a business was liquidated.
Pros of Issuing Shares to Contractors
Better Incentive
One of the main benefits of issuing shares to contractors is that they have an incentive to do an excellent job. This is because there is a tangible benefit to the contractor if the business’ value goes up due to their efforts. It also means that contractors are less likely to cut corners as there is a direct financial interest in the business.
Does Not Impact Cash Flow
Another benefit of issuing shares to contractors instead of paying them in cash is that this does not impact your business’ bottom line. It can often be difficult to have consistent cash flow at the start of a business’ life cycle, so issuing shares allows businesses to work around this. Using your cash flow to pay employees may be beneficial in the short term, but it can cause issues if you are unable to pay other necessities such as suppliers or rent. Critically, new businesses or startups often use contractors as it allows them to outsource work without hiring new employees. Hiring employees means that businesses have to give employees benefits such as leave and minimum wage requirements.
Helps Attract the Best Contractors
High-quality contractors can be hard to attract if your startup does not have a point of difference or is unable to pay market standard rates. Giving contractors equity in exchange for their services helps attract the best contractors, as many larger businesses will not be able to offer this incentive.
Continue reading this article below the formCons of Issuing Shares to Contractors
Dilutes Ownership
A problem with issuing shares to contractors is that it dilutes the ownership share of the current shareholders. Often founders will be reluctant to experience any dilution during the early stages of a business.
Difficult to Remove Shareholders
A further disadvantage of issuing shares to contractors is that it can be difficult to remove them as shareholders in the future. Shareholders have certain rights, so it can be difficult to force them to sell their shares if they are causing issues or not acting in the business’ best interests.
Harder to Attract New Investors
Another issue with issuing shares to contractors is that it can be difficult to attract new investors if it appears that the business has too many shareholders. Investors want to know that decisions can be made quickly and with little bureaucracy, so having too many shareholders may cause certain processes to be slower.
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Key Takeaways
The main benefit of issuing shares to contractors is that the business might not have enough cash flow to pay them. Further, it creates an added incentive to work harder for the business as they have a vested financial interest in the business doing well. However, there are also disadvantages to issuing shares to contractors. One of these is that it causes the stake of initial shareholders to be diluted. This means they may not have as high of a stake in the business as before. A further disadvantage of issuing shares to contractors is that it can be difficult to remove shareholders if there is an issue with them.
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Frequently Asked Questions
If a contractor is happy with receiving shares in exchange for their services, you can issue shares to your contractors.
You should look to all facets of your business to determine its value. It is important that you strike a balance between a high enough price and the price that an investor would be willing to pay.
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